Like water flowing down hill, investment flows to areas of lower tax

Canada is losing the business tug of war with the United States, and it's not just about higher tax rates

“I want to pay more,” said no one ever.

So says a sign at a discount grocery store and few would argue. Grocery stores have to be competitive to survive and prices are a big factor.

Whether we like it or not, countries and provinces also have to be competitive to attract investment and jobs. Like consumers, the businesses that support our economy don’t want to pay any more than they have to, especially in taxes.

Businesses are very aware of the marginal effective tax rate (METR), the total tax burden on any new investment. Like water flowing down hill, investment flows to areas with lower METRs.

Until very recently, Canada’s METR was 20.9 per cent. We benefited from a significantly lower METR than the United States at 35 per cent. Calculating businesses moved investment, profits and jobs from the U.S. into Canada to take advantage of our competitive tax rates. Both the public and private sectors of our economy prospered as a result.

Now the tables are turning. With recently-announced tax cuts, the METR in the States is down to 21 per cent, well below Canada.

Although the changes are too recent to be reflected in statistics, the mere anticipation of the U.S. tax cuts has slowed the flow of investment into Canada to about the lowest it has been in this century.

So far, there has been no evidence of major firms in Canada turning out the lights and moving south. However, many have started to move a few key people and functions below the border and we can guess where any expansions or new investments are likely to go.

And within Canada, British Columbia is now the province to come to if you indeed do want to pay more. At 27.7 per cent, B.C. has the highest METR of any province. Ontario and Alberta are lower than the national average at 19 per cent.

In B.C., we have only ourselves to blame.

In the past, the tax burden in British Columbia was not too far off the national average. That changed when a provincial referendum resulted in our giving up the harmonized sales tax (HST) and re-imposing the provincial and general sales taxes (PST and GST). This meant higher tax rates and double the compliance burden. Taxes in B.C. are compounded with each layer of taxes paid at each stage of production being added into the price of the product and re-taxed at each subsequent stage. The HST, as a value-added tax, doesn’t do this.

The tax burden is important but it’s not the only factor in business decisions. Unfortunately, B.C. and Canada don’t rate well on many of these other issues:

Red tape and regulatory burdens loom large when planning for investments. The U.S. is drastically (though perhaps not always wisely) cutting these. B.C. and Canada are not.

The cost of housing in Toronto and Vancouver, and increasingly elsewhere, puts us at a disadvantage compared to all but the biggest cities in the United States.

Our much-appreciated universal health care does not give us much advantage over medium and large employers who have always provided health coverage to their employees.

Political uncertainties with respect to foreign investment and major projects also deter investment.

If we wish to avoid a serious negative impact from the U.S. tax cuts, we need to take steps at both levels of government to get our respective METRs back down to competitive levels. In B.C., this could involve rethinking the HST. Across the nation, tax levels and other factors such as depreciation and regulatory burdens must be adjusted.

Politicians have downplayed the threat of lower U.S. taxes on Canada and are reluctant to reduce our tax rates. In British Columbia, the cost of government to both investors and individuals has been rising.

Perhaps governments fear that lower rates would reduce their revenues. However, maintaining higher tax rates on a diminishing level of economic activity also threatens government revenue.

Pursuing social goals is often offered as a reason for not lowering taxes. Providing affordable housing and closing the gender gap are important, but we won’t be able to attain them if our lack of tax competitiveness leads to an outflow of investment and jobs.